A stock exchange, in the economic and financial sense, is an institution, private or public, that makes it possible to discover and display the price of standardized assets and to facilitate (match) exchanges under conditions of satisfactory security for the buyer and the seller. A stock exchange houses a regulated and organized market whose presence is permanent, unlike a market (countryside for example) whose presence is ephemeral, but whose functions are similar. It is part of a complex supply chain of order placement, order clearing and delivery of securities (or other).
The stock exchange is an institution of the market economy because it ensures the continuous formation of prices by comparing supply and demand. It is generally supervised by a regulator who ensures its operational neutrality (fair treatment of investors), the proper circulation of information (press releases) and the market police if necessary (notifications, investigations, sanctions).
Stock exchanges were once housed in special buildings designed to accommodate the operators who operated them: brokers, stockbrokers (now defunct), and other members. These members ensured the quotations on the stock exchange through various price formation systems such as auctions, lockers or boxes. Stock exchanges have gradually dematerialized and migrated to computer networks that perform the same functions, without the need for a physical presence of operators in the same place. Purely software operators have appeared in recent decades.
- stock exchanges: shares, bonds, derivatives (options, warrants), UCITS;
- exchanges for raw materials (metals, hydrocarbons, cereals, etc.) or wholesale consumer goods (diamonds, flowers, etc.). Gold and silver have a somewhat special “compartment” status which is due to their former monetary function;
- exchanges specializing in futures, futures contracts (e.g. oil, finished products, e.g. orange juice, financial products, e.g. stock market index), such as the LIFFE.
Used alone in a financial context, the term “stock exchange” most often refers to a stock exchange, commodity exchange or specialized financial products (future-type).
Etymology of stock exchange
The current word “stock exchange” could derive from the name of the hill of “Byrsa” located set back from Carthage, a rich city of the ancient world, 10 km from Tunis, where a temple dedicated to the healing god Echmoun had been built. A wall having been built there, the hill of the sanctuary was a citadel. Today, there is the monastery of the White Fathers and the Saint-Louis Cathedral.
The term “stock exchange”, in its current sense, appears at the beginning of the fourteenth century, in Bruges in Flanders, the place of trade since the twelfth century. This etymology is proposed by Lodovico Guicciardini: the Bruges merchants held daily meetings in a square located in the center of the city at the entrance of which stood a hotel built by the noble family of Buerse (Van der Borsen). On the façade of this hotel were carved his arms of gold with a band of gules charged with three purses of silver. From these various circumstances, the square was soon called ter buerse and finally Borse altogether. Bruges merchants who had continual relations with Antwerp and Bergen op Zoom gave the same name of Borse to the place where they met in these cities to deal with their affairs.
The name was later popularized in France and especially in Rouen and Toulouse where certain places shops and galleries specially adapted for the use of merchants were designated. The same thing took place in London after the completion of the beautiful premises founded by Thomas Gresham Queen Elizabeth having gone to inspect it was very satisfied, but so that it did not appear to have been made according to the plans of the Antwerp Stock Exchange she named it Royal Exchange expressly recommending not to give it another name. “Nevertheless the old designation had so much power that despite the orders of the Queen the local was commonly called Stock Exchange as in Bruges and Antwerp.”
Historical of the stock exchange
In the twelfth century, foreign exchange brokers were charged in France with controlling and regulating the debts of agricultural communities on behalf of banks. These are actually the first brokers. They met on the Grand Pont in Paris, the current Pont au Change. It takes its name from foreign exchange brokers.
In the thirteenth century, Lombard bankers were the first to exchange state debts in Pisa, Genoa or Florence.
In 1409, the phenomenon was institutionalized by the creation of the Bruges Stock Exchange. It was quickly followed by others, in Flanders and the surrounding countries (Ghent and Amsterdam). It was also in the Spanish Netherlands (present-day Belgium) that the first building designed specifically to house a stock exchange was built, in Antwerp. The first stock exchange organized in France was created in Lyon in 1540.
The first recorded stock market crash took place in 1636 in Holland. With tulip bulb prices reaching excessively high levels, the price collapsed on the first of October. This is tulip mania.
In the seventeenth century, the Dutch were the first to use the stock exchange to finance businesses: the first company to issue shares and bonds was the Dutch East India Company, introduced in 1602. It was in 1688 that stocks and bonds began to be listed on the London Stock Exchange.
In 1774, at the Paris Stock Exchange (created in 1724), prices must now be shouted, in order to improve the transparency of operations. This is the creation of the prosecutor’s office.
In the nineteenth century, the industrial revolution allowed the rapid development of stock markets, driven by the significant need for capital to finance industry and transport.
Since the 1970s, we are witnessing the dematerialization of securities traded on the stock exchange thanks to the computer revolution. In 1971, the NASDAQ was the first computerized listing market. In France, dematerialization was effective from November 5, 1984.
Financial markets allow for an efficient allocation of resources.
The stock exchange is first and foremost a meeting place for the supply and demand of standardized products with a view to discovering their price continuously or at certain times of the day (fixing). It provides functions of financing the economy (symmetrically investment for those with cash to invest), risk allocation and management, and securities liquidity. The financial markets make it possible to sell new (newly issued) or second-hand (already issued) securities belonging to an investor. These securities can be traded on regulated markets (often called exchanges) or over the counter.
- Financing of companies: the stock market allows companies to finance themselves, to invest, by directly connecting supply and demand by subscribing to capital increases. We are talking about a disintermediated system unlike the banking system. Through IPOs or capital increases, companies have access to additional financial resources. Scholarships have allowed companies to grow and therefore develop projects that an individual alone could not have financed. For example, the London Stock Exchange was created with the need to finance shipments to Russia and India. Similarly, a boom is given to the stock exchanges with the industrial revolution and the need to finance, among other things, the large railway networks. On August 1, 1836, the Mohawk and Hudson Railroad was the first listed railroad.
A company obtains new resources, through the issuance of shares or bonds, only on the so-called primary market. There are three main types of initial public offering (IPO): firm bid, auction and orders book or placement method.
- Savings orientation: investors with a positive savings capacity can become shareholders of private companies or become creditors of these companies and public authorities. They can invest either on the occasion of a capital increase or IPO on the primary market, or orient themselves on the so-called secondary market on which the securities already issued are traded. The stock exchange allows the mobilization of savings and therefore a better allocation of resources to the most profitable investment projects. By facilitating access to savings, stock exchanges make new investments possible and thus improve the profitability of investments.
- Risk management: The stock market allows risk to be transferred through stock and bond trading. It also allows investors (companies, shareholders, creditors, etc.) to protect themselves from risk (currency risks, interest rates, credit, falling prices, etc.) through the use of derivatives: swaps, futures, futures, options.
- Liquidity of securities: the stock exchange allows the tradability of securities. This facilitation of exit helps attract more investors and explains why venture capital firms want the companies they have invested in to go public.
- Value indicator: stock exchange listings measure the value attributed by the market to a company, commodity or receivable over time. The courses, therefore, make it possible to follow the evolution of the price of products and the general evolution of the economic situation of a country.
- Control tool: listed companies must comply with stricter regulations regarding the publication of their accounts. These companies are also monitored by multiple teams of financial analysts, who widely disseminate all information that potentially impacts the company’s share price.
Assets and contracts processed
Exchanges can deal with a very large number of products, including:
- Financial securities: shares, bonds and other debt securities;
- Derivatives: swaps, options, futures, forwards… Derivatives are underpinned by various financial instruments, raw materials (hydrocarbons, metals, cereals, rights to pollute, etc.).
Currencies are not traded on the stock exchange. When they are convertible, they are traded against each other generally continuously on the foreign exchange market, which is an over-the-counter (OTC) market.
In France, buyers and sellers place their stock market orders through a financial intermediary (bank, management company, financial advisor, etc.) who transmits them to an official member of the stock exchange (called a broker, broker, broker, broker). Since the 1993 European Investment Services Directive (ISD), we speak of investment service providers (ISPs).
The multiplication of operations is made possible thanks to the dematerialization of securities. Transactions take place thanks to computer systems developed by brokerage companies such as NYSE Euronext or the London Stock Exchange. The purpose of these companies is to manage and ensure the proper functioning of the market, as well as to collectively guarantee operations, vis-à-vis investors.
Exchanges were originally mutual companies owned by brokers. Thus, the New York Stock Exchange was created on May 17, 1792, by twenty-four brokers. More and more, however, stock exchanges are also tending to be listed on the stock exchange. Euronext is listed on the Paris stock exchange and is the result of a merger process between various European stock exchanges and then with the New York Stock Exchange in the United States.
Since November 1, 2007, the new European financial regulation (MiFID) allows banks that wish to do so to create their own stock exchange in order to increase competition in the sector. Seven investment banks took the opportunity to create a new common stock exchange, named Turquoise, whose stated goal is to offer more attractive rates than traditional exchanges.
Technical Analysis and Trading
- Technical analysis: Technical analysis is a method that increasingly uses pattern and trend detection algorithms that graphically translate the price of a security to help the trader consider possible scenarios for the future evolution of the price of the value. These scenarios can then be exploited as part of a speculative “trading” strategy aimed at making more money. While many socio-psychological aspects come into play in the valuation of a value, the profitability of these methods is discussed for some sectors (speculative bubbles) but is considered globally lucrative by some banking analyses for other sectors (e.g. for the Forex foreign exchange market). However, speculation is particularly criticized when it does not bring utility, unlike the long-term holder of securities. The systematic search for profit is contrary to Christian morality; The investor should not display his wealth or his stock market successes and he must invest in avoiding risks.
- Trading: Trading is an activity practiced via a computer or a network of computers, most often using technical analysis in order to buy and sell securities at the best price.
- High-frequency trading: this is (with the “flash trading” and the “flash order” associated with it) trading that is entrusted only to software and algorithms with an extremely fast response time and which now monopolize the majority of orders on the stock exchange. The speed of transactions is becoming increasingly important, with new records in the 2010s. In a few years (beginning of the twenty-first century), the share of transactions initiated by robots has increased from 0 to 50% (in 2012) of volumes. In November 2011, more than 90% of stock market orders on the European market were issued by high-frequency traders… While these new traders (“angels or demons” of the financial system?) track latency costs or change the rules by practicing new forms of data snooping with data snooping)… Trading takes place in “thousandths of a second”, hence the name of this approach: “high-frequency trading“; in 2013, according to Marin Scholtus (of the Econometric Institute and the Tinbergen Institute, of the Erasmus University of Rotterdam), “a delay of only 200 milliseconds is considered to significantly harm stock market performance and on days of low volatility, this is already the case for delays in more than 50 milliseconds. In addition, the importance of speed of performance increases in trading rules over time”;
Many experts accuse this technique of evading competition rules (or taking advantage of them abnormally), causing adverse selection bias and being the cause of the “Wall Street flash crash” that in May 2010 plunged the Dow Jones from -2 to -10% in a few minutes. The US Securities and Exchange Commission proposed in September 2009 to ban these practices as part of a reform to better regulate stock markets following the 2008 financial crisis, but in 2011, fast trading was again very present and six years after the 2008 crisis (early 2014) this proposal has not yet been followed and the rate of transactions made by robots has meets or exceeds pre-crisis levels.
Major world stock exchanges
One of the most common ways to assess the economic and financial importance of a stock exchange in the global space is to compare its market capitalization with other stock exchanges. Market capitalization is the sum of the capitalizations of companies listed on the stock exchange. This capitalization fluctuates according to various criteria since a stock exchange is a market. The figures are therefore variable.
Stock exchanges have become private infrastructure for listing assets that are companies, themselves listed. A movement of concentration has begun worldwide in order to build more efficient quotation poles. These mergers lead to the creation of competing transnational entities that specialize in securities quotations and are present in all major markets.
The list of the top ten exchanges in the world, ranked by market capitalization as of March 2018, all of which have been adjusted to the U.S. dollar:
- The New York Stock Exchange (NYSE), United States: $24.49 trillion in January 2021.
- The NASDAQ (National Association of Securities Dealers Automated Quotations), United States: $19.34 trillion in January 2021.
- Shanghai Stock Exchange (SSE), People’s Republic of China: $6.5 trillion in January 2021.
- Hong Kong Stock Exchange (SEHK), Hong Kong: $6.46 trillion as of January 2021.
- Tokyo Stock Exchange (TSE), Japan: $6.35 trillion, as of January 2021.
- Shenzhen Stock Exchange (SZSE), People’s Republic of China: $4.9 trillion as of January 2021.
- Euronext (Euronext Stock Exchange), Eurozone: $4.88 trillion in January 2021.
- The London Stock Exchange (LSE), United Kingdom: $4.38 billion in March 2018.
- Toronto Stock Exchange (TSX), Canada: $2.29 billion as of March 2018.
- The Frankfurt Stock Exchange (Deutsche Boerse or FWB), Germany: $2.22 billion in March 2018.
Long-term global statistics
Credit Suisse’s Global Investment Returns Yearbook 2017 analyzes 117 years (1900-2016) of performance for five asset classes (stocks, bonds, cash, inflation and currencies) in twenty-one countries. It shows that equities generated an average annual return of 5.1%, compared to 1.8% for bonds and 0.8% for treasury bills, while global inflation rose by an average of 2.9% per year. But in the twenty-first century (2000-2016), the return on equities fell to 1.9% per year compared to 4.8% per year for bonds.
In the United States, the 117-year average annual return on equities is 6.4% (2.7% over 2000-2016), in Germany at 3.3% (2.2%), in France at 3.3% (1.7%), in Japan at 4.2% (0.8%) and in the United Kingdom at 5.5% (2.4%). In 1900, the United Kingdom dominated the stock market with 25% of the world’s capitalization, ahead of the United States (15%), Germany (13%), France (11.5%) and Russia (6.1%). Moreover, in 2016, the United States dominated by a wide margin (53.2%) ahead of Japan (8.4%) and the United Kingdom (6.2%); Germany and France have only 3.1% each, Switzerland 2.9% and China 2.2%.
Criticisms of the stock exchange
In the nineteenth century, the founding fathers of the market economy, and in particular Adam Smith, issued recommendations on the ethical conditions for a well-functioning market economy. These recommendations have been taken up by observers of the transformation of society during the Industrial Revolution, including idealistic socialists, Catholic socials, and nationalists, all criticized, for moral and political reasons at the origin, of the opposition between a “real economy” (labor, production, the small owner) to the financial sphere (possibly related, for some, the theme of the rejection of cosmopolitanism). Pierre-Joseph Proudhon, a socialist and collaborator of Karl Marx, was nevertheless very interested in the stock market, from which he derived substantial income through the publication of numerous writings, while denouncing speculation.
Conversely, advocates of speculation point out that it is an indispensable mechanism for society to direct capital to those companies that will be best able to create value and thus prosperity. The economist Jean-Yves Naudet writes: “To maintain that speculators render a real service is not politically correct, but it is scientifically proven.” In this regard, it is necessary to distinguish trading operations, which have little impact on the activity of companies, from real investment operations. Whatever the effects of speculation, it must be understood that for a company to hedge on risk, an actor must agree to take the opposite risk, especially when one company does not have a need exactly symmetrical to another. Speculation is particularly criticized when it is:
- unilateral and destabilizing for the economy (e.g. in the case of deliberate and massive action against a currency);
- close to gambling (hence the expression “gambling on the stock market”) because of the pathological behaviors it can cause;
- or when it systematically exploits a market aberration, in this case, the supervisory authorities must put an end to it. It can in some cases find itself at the border of legality and then be on a criminal ground leading to legal proceedings, for example by artificially causing the rise of security by manipulating supply and demand.
Returning to the theory of the school of regulation according to which the stock market would favor the short term, the economists Augustin Landier and David Thesmar criticize this vision: by taking all the American listed companies in 2004 and taking as an indicator the price to book ratio (valuation by the market of the accounting assets of the company), they observe that those who make losses are valued about 50% more expensive than those who generate profits, the exact opposite of regulation theory. They explain this apparent paradox by the fact that investors are willing to pay for expected profits in the long run. According to them, the real problem comes from stock options that encourage some managers to boost their share price through accounting manipulation, a problem that the authors propose to solve by prohibiting the exercise of options during the term of office.
Criticisms of market efficiency
John Maynard Keynes defended the idea that the “stock market” (i.e. the secondary market) was a “beauty contest”, considering that to win in the stock market, one should not invest in the potentially most profitable company, but in the company that everyone thinks is potentially the most profitable. This difference, which may seem small, actually opens an era where communication is king. According to Keynes, it is not always necessary for a company to be profitable, it may be enough to make believe it to a majority, and to make it known that the majority believes it.
The opposite theory of market efficiency holds that in an open market where many players trade, the price of a security represents exactly its value. With this in mind, it would be useless to try to beat the market by analyzing each stock since thousands of other analysts have already done so and the price already contains all this information. Subsequent price changes would thus be a function of new unforeseen and random events, hence a secondary hypothesis known as random walking. The main author of these two theories is Eugene Fama.
The efficiency of the market in the mechanism of price formation may have been called into question when the formation of speculative bubbles was observed. One of the most famous is the price of tulip bulbs observed in Amsterdam in 1650. Some economists still deny the existence of bubbles while others consider them exuberant behavior, endlessly prolonging past growth rates of an asset’s price with irrational expectations. These bubbles provoke a sudden readjustment of asset prices that can result in a stock market crash. The contribution of neuro-sciences to economics makes it possible to better understand how certain decisions described as rational previously pass through an emotional filter that can disturb them.
Internal criticism from market participants
This category of criticism is not about the existence of the exchange, but about its efficiency and operation. The development of high-frequency trading, the presence of semi-autonomous algorithms that constantly patrol the market in search of arbitrage and latency, but also the development of “dark pools” raise fears that the stock market will increasingly escape traditional investors, to turn into a race for new technologies.
On the side of listed companies, the stock exchange is sometimes criticized for not giving a “fair” valuation to companies, left to market movements or rumors. However, this criticism is limited in scope in a market in which many players are involved. The company quickly understands that improving its financial communication is a key factor in its fair valuation.
For companies with smaller capitalization, financial communication costs or additional regulatory obligations imposed by market authorities can represent significant costs that can become dissuasive; the Sarbanes-Oxley Act passed in 2002 in the United States stopped the admission of foreign securities on the New York Stock Exchange (NYSE) and encouraged growth companies in emerging countries to be listed on the London Stock Exchange. where admission criteria are more flexible.